Why It Pays to Rent Out a Vacation Home for Less Than 15 Days

Julian Block discusses more tax tidbits and explains why it pays for vacation home owners to only rent out their residences for 15 days or less.

Feb 21st 2020
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Tax tidbits
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In twenty-two previous columns, I discussed my use of “tax tidbits” to enliven conversations when talking taxes with clients or speaking to groups like business owners, retirees, investors and home sellers. The tidbits discuss, among other things, IRS rulings, law changes, court decisions and tactics that trim taxes for this year and even future ones.

I‘d like to share more of my favorites with you here.

From a 1974 novel, The Partners, by Louis Auchincloss, a practicing lawyer who wrote polished novels of manners about the white, Anglo-Saxon, Protestant, American upper class: “You are behind the times, Ronny. Everything today is taxes. Common law, constitutional law, even criminal law. They are all soaked in tax questions. What better seat on the grandstand of life can I offer you than that of tax counsel?...Public and private morality, where are they? Submerged in a sea of exemptions, of write-offs, of loopholes, of fabricated balance sheets and corporate hocus-pocus. What is hospitality but deductibility? What is charity, charity that was greater than faith and hope, but the taxpayer’s last stand? Who is the figure behind every great man, the individual who knows his ultimate secrets? A father confessor? Hell, no. The tax expert!”

From the Wall Street Journal, July 28, 1982: “Figuring out your income tax has become so complicated it's created a whole industry that provides work for thousands of people—high-powered tax lawyers and accountants and thriving businesses such as H&R Block. In times when unemployment is so high that could be considered a boon to the economy.”

Current capital gains rates for profits on long-term assets (owned for more than one year). Generally, the rates are lower than the rates for ordinary income from sources like salaries, pensions and withdrawals from IRAs, 401(k)s and other kinds of tax-deferred retirement plans.

The top 20 percent capital gains tax rate is particularly appealing to wealthy investors.They face a top 37 percent ordinary tax rate. The top rate goes from 37 to 40.8 percent for those who are subject to 3.8 percent Medicare surtax.

Capital gains rates also benefit lower-earning investors also can benefit. For those on the lowest end of the tax scale, they face no capital gains taxes, as in 0 percent, on long-term asset sales. Moving up the pay scale and tax brackets a bit, the top capital gains tax rate maxes out at 15 percent.

Why it pays for some owners of vacation homes to avoid renting them out for more than 15 days. An important reminder for owners of vacation homes (or year-round homes, for that matter) near annual events where rents soar for short periods—-for instance, Indianapolis for Memorial Day races, Louisville during Derby weeks, and Augusta during Masters golf tournaments.

The IRS concedes that owners are able to rent out their homes, pocket the rent checks and sidestep taxes on the rental income. To reap this break, cautions the IRS, owners need to make sure to rent out their cottages or condos for less than 15 days during the year.

Things end badly for owners who are unmindful of the calendar and go beyond the less-than-15-days limit. They have to report all the rental income on Form 1040’s Schedule E.

*Letters from the IRS. Jay Leno said: Worried about an IRS audit? Avoid what’s called a red flag. That’s something the IRS always looks for. For example, say you have some money left in your bank account after paying taxes. That’s a red flag.”

While this may be a joke, getting letters from the IRS isn’t. Just seeing the envelopes sends chills down the spines of taxpayers.

My advice for those who receive such letters: Stay steady. In most cases, the letters pose questions that can be easily addressed—for example, missing forms or entries on tax returns that don’t match up with W-2s or 1099s. If you’ve any serious concerns, discuss them with your accountant or other adviser.

Look for more tidbits in subsequent columns.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 300 and counting). 

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